MEXICO CITY—The Bank of Mexico raised interest rates for the first time since 2008, despite record-low inflation and relatively slow economic growth, as the central bank seeks to avoid further pressure on the peso after a sharp depreciation this year.
The Bank of Mexico lifted the overnight interest rate target by a quarter percentage point to 3.25%, as widely expected, in a move that most analysts saw as inevitable after the U.S. Federal Reserve began tightening its monetary policy this week.
In unusually clear language, the central bank said the increase was mainly in response to the Fed’s move “which, in the absence of the adjustment in our own reference interest rate, could generate additional disorderly depreciation of the national currency and affect inflation expectations and inflation itself.”
The peso, which hit record-low levels against the U.S. dollar in early December as the Fed announcement neared, strengthened briefly below 17 to the dollar. It later traded in Mexico City at 17.02, compared with 17.07 before the announcement.
Higher local rates make the peso more competitive. The Bank of Mexico didn’t say if the first rate increase will be the beginning of a tightening cycle. But it emphasized it will be closely watching U.S. monetary policy, suggesting the bank could mirror any further Fed moves.
The increase in borrowing costs is expected to drain money from the real economy and may make government financing slightly more expensive in the medium term at a time of austerity due to low oil prices. Interest rates on mortgages and other consumer loans could eventually rise, but are likely to remain low by historical standards.
“Let’s hope rates don’t rise too much or too fast. It’s a little bit scary,” said Marta Obregón, a small entrepreneur who took out a $60,000 loan at favorable terms to open a bar, and is planning to expand the business in the coming months.
Experts say private banks likely will postpone as long as possible any increase in interest rates to ordinary Mexicans to protect their market share, at a time when total loans and mortgages are expanding at annual rates of about 11% and 17%, respectively.
“To begin with, banks will swallow the interest-rate increase because profit margins continue to be very attractive. I don’t see a major impact in the short term,” said Fernando Soto-Hay, the head of a mortgage consultancy firm. He added that 99% of private mortgages in Mexico are at fixed rates—a lesson from the financial crisis of 1994 when many Mexicans lost homes and cars after borrowing at variable rates.
On the positive side, the rate increase will benefit savers and buyers of government debt. Yields on pension accounts managed by private funds tumbled to 3% in October, compared with 12% in late 2012 when the overnight interest rate was at 4.5%.
The last time rates rose in Mexico was in August 2008, shortly before the collapse of Lehman Brothers, when inflation was running above the central bank’s target. In the last two years, with inflation under control, the bank cut rates four times—the latest in June 2014.
The move marks the first time the five-member board led by Gov. Agustín Carstens has lifted rates since Mr. Carstens took the helm of the bank in early 2010.
In Thursday’s policy statement, the Bank of Mexico said the outlook for local economic growth improved, saying the slack in the labor market appears to be gradually decreasing.
Mexico’s economy expanded at an annualized rate of 3% in the July-September period compared with the previous quarter, the fastest growth in two years and well above expectations, although analysts expect a slight slowdown during the fourth quarter.
Most economists see the central bank raising rates again in February or March, although a number believe the bank could wait longer, particularly if inflation stays at very low levels and the peso stabilizes.
The peso, the world’s eighth-most-traded currency with a daily volume of $135 billion, has weakened around 14% in the past year as prospects of a more attractive dollar dented riskier assets.
But critically, the weak peso hasn’t translated into higher consumer prices. Twelve-month inflation hit 2.2%, the lowest level since 1970 and below the central bank’s 3% target, amid slow economic growth and lower energy and telecommunications prices.
The central bank said it expects consumer prices to remain under control in the next two years, with annual inflation hovering around 3%. It now sees inflation ending this year at 2%.
Write to Juan Montes at email@example.com